All About DONOR ADVISED FUNDS
Disclaimer: This content does not constitute legal advice. You should not act, or refrain from acting, based on the information provided without getting specific advice from your lawyer.
[Research and drafting assistance by Emma Keller, summer intern]
Charitable giving is something many people think about when establishing or updating their estate plan. One tool that has become increasingly popular is a Donor Advised Fund, commonly known as a DAF. Despite their growing use, many people are unfamiliar with how they work or whether a DAF might make sense for them for lifetime charitable giving and as part of their estate plan.
What is a Donor Advised Fund and How Does it Work?
A donor advised fund is a charitable giving account maintained and operated by a sponsoring organization. Many financial institutions have established section 501(c)(3) charitable arms that act as the sponsoring organization to manage DAFs. Establishing a DAF is free at many major sponsoring organizations, and administrative costs tend to be low.
The way it works is that you make an irrevocable contribution of assets to your established DAF, receive an immediate charitable tax deduction, the invested assets in your DAF grow tax-free, and then you can direct the sponsoring organization to send grants from your DAF to IRS-qualified charities of your choice over time. Note that once you fund a DAF, the sponsoring organization has legal control over it, but you retain the ability to make recommendations regarding the distribution of funds and investment of account assets. Popular sponsoring organizations include Fidelity, Schwab, Goldman Sachs, and Vanguard, to name a few.
One major advantage of a DAF is the ability to separate the timing of your charitable deductions from the timing of your actual giving. When you contribute assets to a DAF, you are generally eligible to receive a charitable income tax deduction in the year you made the contribution, regardless of when grants are made from the DAF to charities.
Another critical advantage of a DAF is that if you fund it with long-term appreciated assets like stocks, ETFs, or mutual funds, you generally can avoid paying capital gains tax on the appreciation of those assets. You can also take a charitable deduction on the fair market value of the asset at the time of donation (rather than the cost basis of the asset), subject to certain deduction limits. This can make an enormous difference to you and your charitable beneficiaries. Cash donations to a DAF are generally deductible up to 60% of your adjusted gross income (AGI), and donations of long-term appreciated assets are deductible at fair market value up to 30% of your AGI. If you make contributions to your DAF that exceed these deduction limits, the unused deductions can generally be carried forward for up to five years.
Beyond lifetime giving, DAFs can also play a meaningful role in your estate plan.
How Can I Incorporate a DAF as Part of My Estate Plan?
DAFs can be incorporated as part of your estate plan for flexible post-death charitable giving. In Pennsylvania, the inheritance tax rate on assets passing to charity is 0%, and this includes assets passing to a DAF. A couple of ways you can incorporate your DAF in your estate plan are by naming it as a beneficiary of your retirement account(s) or as a beneficiary of a specific dollar amount or percentage of your estate in your Will.
When you name a DAF as a beneficiary of a traditional (pre-tax dollar) retirement account, the full pre-tax value of the account passes to charity, since charities do not pay income taxes. In addition to the benefits of using retirement accounts to give to charity, which we discuss in this blog post Giving to Charity After Your Death via Your Retirement Account, naming a DAF can also increase the flexibility of donations. If your charitable goals shift, you can adjust your DAF’s charitable beneficiaries, which is often quicker and more efficient than revising your Will and other estate planning documents.
DAF sponsoring organizations also typically allow you to appoint successor advisors (people who can continue advising on grant distributions after you) to your DAF, so you can name people you trust to manage your account in line with your goals and continue your charitable legacy when you are no longer able to.
What are alternatives to a DAF?
Private foundations and direct charitable gifts are two main alternatives to using a DAF in an estate plan.
Private foundations have various setup and administrative requirements related to receiving tax-exempt status under IRC 501(c)(3), but you retain a large amount of control over the management of private foundations. Additionally, while DAF grants must go to IRS-recognized 501(c)(3) public charities, private foundation funds can reach a broader group of recipients. Private foundations often also include family legacy planning options, for example, by naming the foundation after you or your family or by including you and your family members as officers, directors, or trustees. With a DAF, you can appoint family members as donor advisors or successor donor advisors, so there is a possibility for some family legacy planning when using a DAF, too.
Direct charitable giving is a simple way to donate with no setup costs, administrative costs, or a sponsoring organization. For people who know exactly where they want their money to go and want it to go there immediately, direct giving during your lifetime, or after your death through a beneficiary designation or gift under your Will, is often the right choice. Keep in mind that, unlike a DAF, most charities do not accept non-cash assets directly, so if you make direct charitable gifts, you lose the ability to contribute appreciated assets.
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Author:
Mary Beth Melso
Attorney at Law
Commons & Commons LLP
Experience:
Estate Planning
Estate Administration
Charitable Giving